Central & Eastern Europe Economic Outlook October 2017

Government balances come into focus as 2018 budgets are unveiled amid strong growth

Central & Eastern Europe: Government balances come into focus as 2018 budgets are unveiled amid strong growth

October 4, 2017

The Central and Eastern European (CEE) economy recorded robust growth in the second quarter, with activity gaining speed for the third consecutive period. Comprehensive data released by statistical institutes across the region showed that GDP grew a buoyant 4.2% annually in Q2, above Q1’s 4.0% growth and slightly above the preliminary estimate of 4.1%. The CEE economy has flourished so far in 2017 thanks to rebounding investment led by EU development funds, tight labor markets and booming activity in the Eurozone, the region’s key trading partner.

The upward revision to regional growth in Q2 was due to better-than-expected GDP figures for Estonia, Lithuania and Slovenia. Growth in Estonia surged to a multi-year high of 5.7% annually in the second quarter on the back of a double-digit increase in fixed investment and a pick-up in private consumption. Strong demand from the Euro area boosted the Lithuanian economy, while Slovenia also grew healthily, albeit at a slightly more moderate rate than in Q1.

Supportive fiscal policies have been another driving force behind the region’s robust momentum this year, while strong revenues so far have helped keep fiscal deficits in check. Poland accumulated a budget surplus of nearly PLN 5 billion in the January–August period and has seen tax revenues soar due to a clamp down on tax evasion. Croatia’s deficit fell to the lowest level seen in years in H1. In addition, the Czech Republic’s public finances are expected to be balanced this year, thanks in part to very low unemployment. However, Romania stands out as the regional weak spot in terms of finances and is the only economy expected to have a fiscal deficit over 3.0% of GDP in 2017. Although a spending spree by the government has caused the deficit to widen, strong economic momentum is boosting revenues.

Several governments across the region have started unveiling their budgets for 2018, and overall FocusEconomics analysts see fiscal deficits widening slightly from 2017. Poland’s budget shortfall is seen growing next year, as ambitious spending plans are combined with a hit to revenues due to the lowering of the retirement age. In contrast, the Czech Republic is targeting a slimmer deficit, despite being faced with higher costs next year due to a rise in public sector salaries. However, the Czech draft budget will likely be voted on after the upcoming 20 and 21 October election and could be changed by the new government. Any changes are expected to be broadly minor, as both of the country’s largest parties agree on a similar fiscal stance.    

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Growth set to peak in 2017 and slow in 2018

The FocusEconomics panel sees growth in the CEE region this year peaking at the highest rate since 2007. GDP is projected to expand a buoyant 4.0%, with both domestic and external demand growing robustly. Next year, analysts see GDP increasing a more moderate 3.4%, which is up 0.1 percentage points from last month’s forecast, as tailwinds from stronger global trade and accommodative policies fade.

This month’s upgraded 2018 outlook is due to higher forecasts for eight of the economies in the region, including regional heavyweight Poland. Meanwhile, Hungary and Romania’s forecasts were left unchanged, while Bulgaria was the only economy to have its prospects downgraded.

Romania is projected to be the region’s fastest-growing economy next year, with an expected expansion of 3.8%. Poland and Slovakia are also seen achieving fast growth rates of 3.5%. On the other end of the spectrum, Croatia is projected to be the CEE region’s laggard, with an expansion of 2.7%. 

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CZECH REPUBLIC | Strong economic momentum bodes well for administration in upcoming vote

Czechs are gearing up for elections later this month amid buoyant economic growth, as businesses struggle to fill vacancies. Recent data suggests economic activity continued to grow robustly in Q3, after strengthening in Q2 on the back of a broad-based expansion. In July, growth in both industrial production and exports accelerated, benefiting from high demand for motor vehicles, and the latest PMI readings indicate that manufacturing output increased throughout Q3. The strong economy was also reflected in improved economic sentiment in September and tightening labor market conditions, with the unemployment rate hovering near a multi-year low in recent months and wages increasing at the fastest pace in a decade in Q2. The results are a testament to the current administration’s successful management of the economy and will carry some weight in this month’s elections.

The economy has shifted into a higher gear and growth is expected to accelerate this year. It should remain strong in 2018 as fixed investment benefits from increased inflows of EU funds, household spending expands on the back of healthy labor market dynamics and external demand for Czech products remains robust. Furthermore, the outcome of the parliamentary elections should not change the prudent fiscal approach taken so far by the current governing coalition, which bodes well for the future evolution of the public debt. FocusEconomics Consensus Forecast panelists see GDP growing 3.8% in 2017 and 3.0% in 2018, up 0.2 percentage points from last month’s projection.

HUNGARY | Incoming figures point to healthy H2

Revised data confirmed that yearly GDP growth reached 3.2% in the second quarter. Despite decelerating from Q1’s multi-year high in annual terms due to a weak external sector, the country’s economic fundamentals remain solid as evidenced by solid quarter-on-quarter growth in Q2. Likewise, fixed investment and private consumption, the main engines of growth, grew at a solid pace in annual terms thanks to the ongoing fiscal stimulus, the resumption of EU investment inflows into the economy, an expansionary monetary policy and a tight labor market. This suggests that the positive momentum will carry into the second half of the year and should propel economic growth to its fastest annual rate of expansion in years. Adding to the good news, business confidence reached an all-time high in September, and the challenges that affected the external sector in the first half of the year, such as capacity constraints, should dissipate in the upcoming quarters.  

Hungary’s economic outlook is promising. The domestic economy will continue benefiting from favorable monetary conditions, the government’s aggressive fiscal stance ahead of next year’s election, increased investment, a strong labor market and elevated consumer and business confidence. FocusEconomics panelists project the economy will expand 3.7% in 2017. For 2018, they pencil in growth of 3.3%, which is unchanged from last month’s forecast.

POLAND | Spending boom fuels robust activity

Robust consumption dynamics have been the economic story to beat in Poland for over a year, and they remain critical to the country’s growth prospects, having shown no signs of abating thus far in H2. Hinting that household spending remained upbeat since its impressive outturn in Q2, retail sales continued their ascent in August while unemployment ticked down. Other indicators pointed to an acceleration in industrial activity, with industrial output jumping in August on strong growth in the energy sector, and the manufacturing PMI reaching a six-month high in September as new orders soared. That said, the sluggishness of investment—another long-running economic story that had registered a small turnaround in Q2—appeared to worsen in Q3, with business confidence edging down throughout the quarter.

Household spending is expected to bolster growth this year and next. Moreover, investment is expected to make a full recovery this year and then improve sharply as EU funding continues ramping up. Strong European demand will keep upward pressure on export growth, although consumption-driven imports will limit the sector’s contribution to growth. Downside risks continue to stem from the ongoing dispute between the government and Brussels over judicial reforms. FocusEconomics panelists expect GDP to grow 3.9% in 2017 and 3.5% in 2018, which is up 0.1 percentage points from last month’s forecast.

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ROMANIA | Political wrangling over tax cuts threatens investment

Romania drew attention in H1 as the fastest-growing country in the region, defying expectations. However, political wrangling has recently dominated headlines as the government attempts to lay out fiscal policies for public sector wage hikes, tax cuts and increased infrastructure spending. Contentious discussions over 2018 tax cuts are creating the impression of unpredictability in the political arena, which could push away investors. Business sentiment has worsened, and analysts were more pessimistic about current economic and business conditions in August. Furthermore, without significant amendments, the government’s ambitious spending plans could put it over the European Commission’s established 3% of GDP deficit ceiling, which could result in an excessive deficit procedure and hurt Romania’s markets and credit ratings. Chaotic policy making could put the economy at risk of overheating if economic growth is unsustainable.

The economy is expected to slow slightly in H2, but will continue to be supported by strong domestic demand. Higher wages could dent Romania’s competitive edge in labor costs as wages rise above neighboring countries’ and if they are not matched with gains in productivity. Furthermore, investment has remained stagnant and is much needed to revive aging infrastructure. Our panelists predict an expansion of 5.2% in 2017, with growth of 3.8% penciled in for 2018, which is unchanged from last month’s forecast.

MONETARY SECTOR | Inflation rises to highest rate since March 2013

According to an estimate produced by FocusEconomics, inflation in the CEE region rose in August, coming in at 2.0% following the 1.8% print in July. August’s result marked the highest reading in over four years. The majority of the region’s economies saw higher price pressures in August, largely due to more elevated commodities prices.

FocusEconomics panelists see inflation averaging 1.9% in 2017. In 2018, inflation is expected to rise slightly to 2.3%, which is up 0.1 percentage point from last month’s forecast. 

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Angela Bouzanis

Senior Economist 

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